Last Breath. Why the Merkel/Sarkozy “Solution” to the European Debt Crisis Will Fail … Miserably

On June 3^rd, 2009 German Chancellor, Angela Merkel, while addressing a crowd in Berlin, rebuked the European Central bank and counterparts in Britain for having gone too far in fighting the financial crisis, which may be laying the ground work for another major financial meltdown. Merkel said, “We must return together to an independent central bank policy and to a policy of reason, otherwise we will be in the same situation 10 years from now.” In other words, it was not the policy of the European Central bank or counterparts to “bail out” failing financial institutions or governments which acted recklessly with lending or borrowing money without justifiable means to repay. It was statements like these that earned Angela Merkel the title of the “Worlds Most Powerful Woman” by FORBES from 2006-2009.
In many ways, Angela Merkel was considered the only true hope for the future of the European Union. Her words were reminiscent of great financially responsible leaders like Ronald Reagan. It was her conservative leadership and policies which centered on fiscal responsibility making Germany an attractive country for investors. We achieved incredible returns in ETFs like (NYSEArca: EWG) iShares MSCI Germany, returning nearly 40% since the lows of 2008. Merkel outwardly opposed using taxpayer money for the excesses of other governments and poor judgment of investors.
In last week’s blog titled “Unraveling: The economic recovery that wasn’t and how to invest through the declines ahead,” I stated, “Europe is a colossal mess, and U.S. treasuries actually looked surprisingly like a ‘safe haven’”, as one of the reasons the U.S. Treasury market rallied. I also stated that German banks, which are the biggest European Union lenders, “will suffer the most through the defaults and bailouts, causing a depression in Germany like few have seen in their history.” I went on to say, “Angela Merkel has consistently opposed the terms of the Greek bailout because she is well aware of the domino effect which could begin after they fully agree to the terms — this making them the guarantor of several irresponsible countries with no ability to pay them back.”
On Friday, Angela Merkel “caved” on her tough stance which involved mandatory participation of the private sector, (banks, financial institutions etc.) and said she would back a “voluntary” participation of banks and financial institutions in the bailout of Greece. This due to the pressure of the threat that it was mandatory that they strengthen the European banking system and support the weaker economies of other European countries to avoid a complete meltdown.
This situation is reminiscent of our bailouts of banks like Citigroup (NYSE:C), Goldman Sachs (NYSE:GS), AIG (NYSE:AIG) and many others under duress from our central bank asserting that the United States had to cough up billions of taxpayer dollars or our economy would collapse. U.S. taxpayers were forced to pay for the stupidity and recklessness of our banks and financial institutions that frivolously lent to individuals with no justifiable means of repayment and then leveraged those loans through complex derivatives which caused the financial collapse of 2008. The banks got the money and we (the tax payers) got the bill while banks like Citigroup hid these complex derivatives by labeling them, short term debt.
The market broke its six week losing streak this week because of what was viewed as “progress”on the European debt crisis due to Merkel and Sarkozy “caving” on the threats of banks who lent irresponsibly to countries, leveraging their European Union status to borrow recklessly. The only thing more incompetent than a country that borrows what they can’t repay is the institution that lends to them and then adding to that stupidity leverages that loan to create other loans. Rating agencies stated this week that a default in Greece or any other weak European Union country like Portugal, Ireland or Italy would cause them to no longer permit that debt to create other loans. Thus, more defaults and a catastrophe in the European Union that, as Angela Merkel stated in Berlin in 2009, “would take 10 years to solve.”
The question is what forced the hand of Angela Merkel and Nicolas Sarkozy to back what will be a European central bank bailout involving what she opposed which was “using taxpayer money for the excess of other governments and the poor judgment of investors (meaning banks and financial institutions).” She became aware that banks and financial institutions have a far worse exposure in lending to these weak countries and if these countries default, the domino effect will begin, causing a large majority of European banks to fail.
The bond and equity markets should not celebrate this “change of heart” by Merkel, but instead should brace themselves for the European Union taking its “last breath.” They should prepare as the inept, undercapitalized European central bank and IMF try to revive an economy that has been on life support, with banks on the brink of insolvency. Banks that have been hiding risky leveraged loans in complex derivatives, revealing the “worst of scenarios” austerity measures which harm individuals along with a failed financial system which catapults economies into turmoil. These loans were made to countries not just individuals or institutions; the aggregate of bailouts to banks and sovereign entities in the European Union will exceed all bailouts of the financial institutions in the United States.
I believe that Angela Merkel regrets Germany entering the European Union in 1990, but since she didn’t become chancellor until 2005, she didn’t have the opportunity to vote.
Even for a truly conservative, fiscally responsible leader as chancellor Merkel, it was Germany’s membership in the European Union which will create a catastrophe even she can’t stem. Merkel and Sarkozy appeared to stand in unity on Friday in developing a plan to rescue the European Union. Instead, they will stand separate and watch the economy of the European Union draw its last breath.

Unraveling the Economic Recovery That Wasn’t and How to Invest Through the Declines Ahead

Jeffrey Sica predicts a 15-20% correction by the end of summer.

In a quote by Winston Churchill, “We must beware of trying to build a society in which nobody counts for anything except a politician or an official; a society where enterprise gains no reward and thrift, no privilege.”
Stocks have declined for 6 straight weeks with the S&P now down 7% since April. In  my  Forbes blog post dated April 9^th, “Post Interlude how to Invest During the Curtain Call of the Market Rebound”, I stated  we are, in fact, experiencing the  “curtain call” of the market rebound. The market has continued to decline since, with each and every decline becoming more severe, along with some rallies, but overall, a very ugly picture.
My outlook has become increasingly bearish since my February 28^th Forbes blog post entitled “The Law of Unintended Consequences”, where I looked at what our central bank’s easy money policy had created. This policy has been inflating everything from commodities to stocks and bonds while having very little impact on the overall health of the U.S. economy. However, we reached our maximum level of bearishness, lowering equity exposure to around 10-15% with incredibly high levels of cash following the release  of the May 14^th Fed minutes from the April meeting. While not going into full detail, the overriding cause of negativity was that it became clear that our central bank “had taken ownership of the stock market”. Due to their track record of “ownership” of our economy, which has shown virtually no improvement since “QE2”, the markets, inflated by the “easy money” policy, would begin to deflate. At that point, I predicted a 15-20% correction by the end of the summer.
Last week, Ben Bernanke made it clear that QE2 was scheduled to end on time in June. As a result, the bond market responded surprisingly well and rallied with ten year yields declining to a low of 2.9% for two reasons;
1.)    Europe is a colossal mess. Despite severe deficit trouble, Tim Geitner’s threat that “the U.S. will begin to default on its obligations if the debt ceiling isn’t raised by August 2^nd” and further stating that “default could cause a crisis more severe than the one we just came out of”, made U. S. treasury bonds look temporarily attractive, when compared to the alternatives — which shows the desperate economic conditions outside the U.S.
2.)    Investors just do not believe that the economic stimulus program will end in June. Despite statements to the contrary and reflecting back to the Fed meeting in April, the Fed stated that it will “Do what it has to do to stimulate the economy if we experience slowdown”. It is clear that investors are hoping and counting on a QE3 type bail out to save the day.
As QE2 ends, debate of the debt ceiling begins which will undoubtedly show Washington at its worst (perhaps not quite as bad as what Democratic Congressman Anthony Weiner showed us this week), but bad none the less. Republicans and Democrats are so far apart on solving this debt crisis that any agreement will be insufficient in accomplishing the goal of “fiscal responsibility”. As Churchill said, they have become the “all that counts” and free enterprise has taken a back seat. Those businesses or individuals “who have acted with responsibility and thrift are receiving no reward”, are becoming disheartened.
In contemplating the months ahead, I continue to predict a 15-20% correction in the U.S. equity market by the end of the summer and recommend no more than 15% exposure to equities, with no desire to buy and hold. I have decreased or abandoned most prior stock valuation instruments such as cash flow analysis, price earnings ratios and technical, as well as fundamental analysis. This due to the fact that much of the earnings booked last quarter were due to low borrowing costs which cannot and will not last forever. Companies like Johnson and Johnson (NYSE:JNJ) and Google (NASDAQ:GOOG) which are borrowing long term for 1-3% and converting that borrowed money to revenue is just a short term fix if economic conditions don’t improve dramatically.
Thus far we have been seeing deteriorating economic conditions for the consumer as evidenced by the over 9.1 % unemployment rate, manufacturing, GDP and most recently, the revelation by Robert Schiller (housing market guru), who said that he would not be shocked if he sees home prices decline another 10-25%. Borrowing costs will increase, as any attempt by the central bank to keep rates lower will be met with resistance and QE3 (which will keep borrowing costs low) will not be readily accepted as evidenced by the refusal of House republicans to raise the debt ceiling. Therefore, we will continue to add to our treasury short positions through NYSE:TBT, NYSE:TBZ, and NYSE:TBX.
The more effective strategy is the supply /demand theory which is much more oriented toward the purchase of raw materials, where supply is low and demand is high. We are also utilizing analytics involved in demographics, like weather, currency and supply, base metals, precious metals (NASDAQ:PALL), corn, copper, grain, other agriculturals and oil, as well as initiating sales when these supply/demand numbers shift and prices decline. However, supply and demand analysis is complicated, given that these ratios could shift instantly. Therefore, we are using various stop-losses, expert sources and somewhat unconventional methods of analyzing supply and or demand.
Certain raw materials like grains (NYSE:JJG ) have a somewhat fixed level of supply and no attempt to increase that supply, such as fertilizer improvements through companies like Monsanto (NYSE:MON) have been developed to meet that supply. Utilizing weather experts and direct import/export data is one of our means of deciding which commodities to buy, hold or sell. However, the market is extremely volatile, so we may often be quick to sell.
We continue to be buyers of oil, despite rumors of Saudi Arabia increasing output, we see a substantial upside. Although we may not see the $200 per barrel originally predicted, due to the slowing European economy, which should increase the value of the dollar, we feel confident that prices will continue to rise. Relying on the Saudis and the other OPEC countries to keep oil price low through output increases is something that will not last for very long. High oil prices not only benefit their economy and enhance their stronghold on world economy, but the remainder of the OPEC countries as well. The 10 million barrels a day that the Saudis will supposedly release starting next month will be insufficient to keeping oil prices low.
China’s potential economic slowdown caused by several interest rate increases, will reduce demand, but only slightly since their economic stimulus packages of 2009 (which was far more extensive than ours) will do little to curb demand. The only significant decline in the demand for oil and other commodities will come from Europe as we begin to see the European banking system implode due to exorbitant leverage and the ineptness of the European Central Bank and the IMF to solve the crisis. German banks, which are the biggest European Union lenders, will suffer the most through the defaults and bailouts, causing a depression in Germany like few have seen in their history. German Chancellor, Angela Merkel has consistently opposed the terms of the Greek bailout (Germany being the biggest lender to Greece), because she is well aware of the domino effect which could begin after they fully agree to terms — making them the guarantor of several irresponsible countries with virtually no ability to pay them back.  The European debt crisis will also be an added factor in the global declines we will see this summer and could lead to a revision of our downward projection of our 15-20% by summer’s end.
To quote Alexander Hamilton, “It’s not tyranny we desire; it’s a just, limited Federal government.” President Obama may refer to our recent economic setbacks as “bumps in the road” and Ben Bernanke may promise us that “in just a little while” things will turn around. Tim Geitner may threaten Armageddon if we don’t do what he says, but in the end we should realize that, to quote Ronald Reagan “Government tends not to solve problems, only to rearrange them”, and any reliance on government policy for investment returns may offer only temporary solutions. To quote King Solomon “money can grow wings and fly away”. As Churchill said, it is free enterprise and thrift that will save society, and in our case, our economy. Vigilance through discipline will allow us to profit in these difficult times.

Cheating Gravity. Is The Market Rebound Over?

Six-time Grammy award winning Alternative Rock band, The Foo Fighters recently released their seventh album entitled “Wasting Light”. The first two lines from the single entitled “Rope” read; “This indecision’s got me climbing the walls. I’ve been cheating gravity and waiting on the fall”.
These two verses articulate what has been occurring recently with both the equity and commodity markets.  Investors are filled with indecision, “climbing the walls, feeling as if they have been cheating gravity and waiting on the fall”. Most investor indecision revolves around a question that comes courtesy of the central bank; “Will this be the end of “easy money” (QE2) or low interest rates (courtesy of the Fed), as expected in June?”
The outcome can further slow down an economy which has been showing signs of inflation in things like oil prices and commodities combined with sluggish growth in unemployment, housing, and of course, our Gross Domestic Product, which slowed to 1.8% in the first quarter. This is clearly indicating “stagflation”.  The equity market has been “overvalued” for quite some time now, “cheating gravity and waiting for a fall”. The decline has already begun and will continue unless our central bank initiates a creative way to add liquidity. Although they will not call it “QE3”, that is exactly what it will be, causing equity prices to once again inflate considerably to unsustainable levels.  We will, once more, wait for an even greater fall.
The inflation seen in the commodity market began to unravel this week as a result of China tightening interest rates and the dramatic fall of oil prices, which declined nearly 15% last week. This inflation can especially be seen in oil and precious metals and is caused by excess liquidity and global demand in addition to a historically weak dollar.
Furthermore, silver, nicknamed “the devil’s metal” for its tendency to be incredibly volatile, plummeted 35% this past week, after surging 175% from August to a peak of $50.00 two weeks ago. However, for those who can endure high levels of volatility, we continue to recommend the purchase, considering demand is very high, due to the fact that 70% of the silver being mined is being used. Oil prices will continue to be volatile, but move higher due to global demand, weakness in the dollar and Middle East unrest. Therefore, we maintain our recommendation of the purchase of oil.
Still, a strong dollar resulting from rising interest rates, which would add to our overwhelming deficit, would cause us to lower our expectations for price appreciation, as well as any attempt to further restrict trading at the CME – the price controls that were designed to slow what has been termed, “speculation”.
In other words, the Obama Administration does not want to accept responsibility for the high energy prices which are very much their fault and, would like to pass the blame along to these nameless, faceless, “speculators” or who we would call “investors”. Could this be their way of not taking responsibility for the “stagflation” they caused?
The strength of the dollar and the fear of an economic slowdown have been blamed for the declines in the commodity market. The commodity market will continue to be volatile; however, dollar strength will be temporary. Therefore, we continue to recommend the purchase of gold (NYSE:SGOL), silver (NYSE:SIVR), platinum (NYSE: PPLT) and palladium (NYMEX:PALL), due to the lack of faith in currency in general and the complete lack of faith in governments around the world to preserve the value of their currency. The strength of the dollar has been the result of the weakness in Europe, among other things and may continue. However, we would refrain from purchasing U.S. dollars due to the strong likelihood that our central bank will discuss further stimulus, (but not call it QE3), in its minutes which will be released on Wednesday. At that point, we would be buyers of the dollar short (NYSE:UDN) and would anticipate the dollar falling further. We will continue to purchase short U.S. treasury positions like (NYSE:TBX) (NYSE:TBT) and (NYSE:TBZ) and capitalize on the inevitable rising interest rates whether or not the Federal Reserve remains committed to ending QE2 as scheduled in June, along with having no further recommendations for stimulus. However, we feel that the likelihood of this is as remote as our government coming to a solution regarding our national debt by the summer.
Currently, there is still a potential in the commodity market for further advancement and therefore we would be buyers of base metals like copper (NYSE:JJC), which due to the perceived slowdown in China, resulting from several interest rate increases, tumbled last week. China is foreshadowing future conditions in the U.S., which is clear “stagflation”. In this circumstance where interest rates increase but demand factors and inflation remains, a very volatile economy results, confirming a bearish stand on the U.S. equity market. The only trading opportunity is short term and short positioning, with absolutely no willingness to “buy and hold”. Unless fundamentals change dramatically, anticipate a decline in the equity market of 15-20% by the end of the summer, with a potential further decline, should our economy continue to spiral into stagflation.
Another verse from the Foo Fighters’ song, Rope states, “How did this come over me, I thought I was above it all. All of our hopes gone up in smoke”. If we are defensive early, surrender the “above it all” attitude and adjust portfolios early, our hopes won’t all go up in smoke. Instead we can capitalize on the opportunities that exist even in volatile markets such as these.

It’s a Long Way from Wrong to Right

The movie “Crazy Heart” is a story of an “out of control” alcoholic country music star who is trying to get his life together after beginning a relationship with Jean, a young  journalist portrayed by Maggie Gyllenhall. “Bad Blake”, played by Jeff Bridges, enters a treatment center for alcoholism and thus attempts to make amends with his only son who coldly hangs up on him after professing “It’s too late”. In a later scene “Bad Blake” recounts the phone call to his AA sponsor and friend, Wayne, played by Robert Duvall. He said “I was wrong to call my son”. Duvall in the profound wisdom of a good friend says “you were wrong for leaving him 25 years ago and wrong for not trying to find him for 25 years, but you called him and now you’re right – he’s wrong. It’s never too late, son, keep after it”.

The scene can be applied to many aspects of life, including investing.  The fact is that every investor has at sometime sat staring at an investment and said “it’s too late”.  Some buy into the ultimate lie of “buy and hold”. Others just give up and sit in cash. Still others, with the wisdom of Bad Blake’s friend Wayne, make the right decision and move forward — always keeping after it because it is never too late to start making the right investment decisions.

In the months ahead, it will become evident that investors will make investment decisions which leave them saying “it’s too late” or proceed on a path to success by “keeping after it”. The reality is the markets have become irrational. It is apparent that we are at a critical point and the stakes have never been higher.
The recent downgrade of  U.S. Treasury debt is relevant when it comes to the long term outlook of the economy. As a matter of fact, I predicted this downgrade on March 21, 2011 on my blog on Forbes. With news of the downgrade, the market plummeted 200 points but rebounded by the end of the week to reach a 3 year high.

There were two reasons why the market rebounded with such velocity by the week’s end, while ignoring the downgrade. The first is the fact that S&P and Moodys have completely undermined the confidence of investors in their 2008 assignment of the highest credit ratings on sub-prime mortgages along with their failure to warn investors of the risk involved in holding those securities.

This is further exasperated with the recent disclosure by the Senate that they were pressured by Goldman Sachs (NYSE:GS) UBS AG (NYSE:UBS) and at least six more banks. And, according to Senate reporting, they were lessening their standards to accommodate these institutions.  The end result was investors didn’t know what they were buying because the big banks were “paying off” the ratings agencies in order to benefit themselves — investors were nearly destroyed in the process. If this fact doesn’t seriously impair the confidence of investors in the ratings agencies and the “big banks” and large financial institutions who control them, they will inevitably reach a point where it is “too late” by following their most often wrong advice.

The second reason investors are ignoring the negative outlook from S&P on U.S. treasury debt is the “bullish” analysts and financial institutions’ catch phrase “well the U.S. Government could always print more money to pay for those bonds”. The problem with this half-witted strategy is that at some point in time, most likely in the next few months, real inflation will exceed the yields these bonds are paying, rendering them unattractive.

Consequently, this will create an even greater bubble than already exists and subsequently, the vast majority of the diverse holders of our debt will dump their holdings at a rate we have never seen before. Printing more money at this point will only increase the devastation of stagflation and further erode the value of the dollar; making a bad situation worse.

The ratings of the U.S. Treasury bond by several rating agencies could fall to the AA+ at some point during the summer due to several factors. First off, the 2012 Obama budget and the Republican Budget proposal are so incredibly different, second is the lack of potential to reach any agreement, and finally the lack of willingness to address the hard issues. For these reasons, they have created a severe threat to U.S. debt and as a result, ratings agencies have an obligation to respond.

The overall debt to GDP is among the worst world-wide. If there is no action, the debt will compound at a substantial rate in relation to GDP. Without the option to print money, in any other situation, we would most certainly default on our obligations. The only reason rating agencies haven’t drastically reduced ratings as they did in some European countries, is because the U.S. has displayed a willingness to print money.

Of the recent bond issuances since last September, the Federal government has purchased 70% of its own debt, increasing the compounding effect of the deficit. Under these circumstances, a AAA rating is no longer warranted. U.S. Treasury bonds getting downgraded to below AAA rating will have significance to corporations, pension funds, and the like and the implications are too numerous to list causing dramatic declines in both the bond and stock markets.

The stock market has rallied, mostly due to the liquidity the Fed has provided; yet, it is scheduled to terminate in June. Our decision to turn more bearish is due to this “over-inflated” market losing the liquidity which drove it to these levels. Furthermore, any attempt to raise taxes, print more money or invent another exotic method of supporting our economy will only lead to even greater inflation or worse, stagflation.
Oil prices will continue to rise to the $200.00 barrel range as well as other commodity prices as a result of the excess liquidity. Consequently, those who aren’t positioned correctly will, in an instant, realize “it’s too late”.
The movie “Crazy Heart” did not end as most would think. Jean, Bad Blake’s true love and inspiration, the woman he turned his life around for, moved on with her life. Thereupon, he was left alone with his guitar to walk off into the sunset. At first it seemed like it was too late and that he had lost everything he loved or cared about. But, it became apparent that his loss led to his greatest achievement, which was a future with promise, or as someone once said “Maybe life isn’t about getting back what you lost, maybe it’s about getting what you never had”. We could say the same for our investments.

Post Interlude: How To Invest During The Curtain Call Of The Market Rebound

Jeff discusses replacing the U.S. dollar as the world’s reserve currency.
In the 1500s, most theatrical plays were dark and somewhat depressing with a religious theme to essentially make people feel guilty about … just about everything. Unlike today, most entertainment was not meant to help people escape. A play about the “Black Plague” was often considered “the feel good hit of the year”.
To keep the audiences from stampeding out the doors when the despair became too much to endure, the guilt mongers of these dark, depressing dramas added a break in the action called an “interlude”.
They were short, light-hearted, upbeat skits of some sort, such as a puppet show. The father of the interlude was English writer, John Heywood, known for his entertaining and often comical interludes.
The interlude would keep people in their seats and was a great distraction from the dark despair and overwhelming condemnation that they were about to be exposed to in the remaining scenes of the morality play.
As one modern multi-academy award winning producer said, “the only thing worse than people not showing up, is people leaving early”.  The interlude was designed so people wouldn’t leave prematurely and, just as today, entertainment was dependant on putting and keeping people in their seats.
In the so-called recovery in the equity markets since 2008, we have endured what could be considered an “interlude” to a very dark and somewhat depressing story. This “interlude” resembles a not-so-funny puppet show of government bureaucrats, central bankers and Wall Street illusionists, who have systematically destroyed the value of the dollar and inflated everything from stocks and bonds to commodities — especially oil.
Furthermore, for the first time in history they have borrowed and spent our country into an unprecedented deficit, which will almost certainly cause “the first credit rating down-grade of our national debt in history”.
These same reckless bureaucrats are apparently willing to entertain the possibility of embracing a foreign currency to replace the U.S. dollar as the world’s reserve currency, as illustrated when Tim Geitner said he is “quite open” to  Chinese proposals for the gradual development of a global reserve currency run by the international monetary fund. This statement should depress every hard-working, taxpaying American.
In the events of the last few weeks, it has become evident that we are nearing the end of an “interlude”. Much like the English theater goers of the 1500’s, who could either brace themselves for the upcoming events, or leave, we too have a choice.
We can adopt a strategy to invest in those things which will appreciate in value; things like precious metals, gold (NYSE:SGOL), silver (NYSE:SIVR), palladium (NYSE:PALL), platinum (NYSE:PPLT) or commodities — especially those which will be used to help rebuild Japan, such as base metals copper (NYSE:JJC) and aluminum (NYSE:JJU), global water (NYSE:PIO) and oil.
The alternative, those investors who are still investing in bonds and bank stocks, would be likened to the theater goers of the 1500’s, who, after enduring the pain and misery of the matinee, are choosing to sit through the evening show, with the hopes that maybe the end will be happier the next time around.
Theater has dramatically changed since the dark days of the 1500’s.  A new form of entertainment has emerged in the theater and movies of today.  Films such as “The Fighter” or “The Kings Speech” depict overcoming great adversity to triumph.  Investing in this challenging environment will involve much of the same diligence, or, to quote John Heywood, “nothing is impossible to a willing heart”.

The Law of Unintended Consequences: The Worst Mistake in Decades

By JEFFREY SICA

Image by AFP/Getty Images via @daylife

 Jeff discusses the concept of unintended consequences as it relates to decisions made by the Fed.

The law of unintended consequences has long existed dating back to at least Adam Smith but was popularized in the twentieth century by sociologist Robert K. Merton. In his theory, Merton stated that often unanticipated consequences or unforeseen consequences are outcomes that are not the outcomes intended by a purposeful action. In some cases, the law of unintended consequences could create a perverse effect contrary to what was originally intended and ultimately making the problem worse.
 In the economic downturn of 2008, the central bank undertook a series of what they considered “positive initiatives” to stimulate the economy. Fed Chairman Ben Bernanke defended his position by saying that the policy of “quantitative easing” (bond purchasing), will “stimulate the economy and create jobs”.  In other words, stimulate the economy by printing massive amounts of money.
 The unintended consequence of these initiatives will prove to be catastrophic in the long term. The cause of this unanticipated consequence is something Merton called the “relevance paradox”, where decision makers think they know their areas of ignorance regarding an issue, obtain the necessary information to fill that ignorance void but intentionally neglect other areas as its relevance is not obvious to them. This is exactly the case with our central bank.

 To clarify, Ben Bernanke has intentionally ignored the short term consequenceof his QE initiative through a justification of the potential long term positive effect.  In recent testimony before capitol hill, Bernanke stated, “while indicators on spending and production have been encouraging on balance, the job market has improved only slowly” adding, “it will be several years before the job rate is back to normal”, despite some positive signs that cropped up in January. Bernanke has chosen to ignore the negative “job market” consequences by stating that it will recover in a few years and focus on the minor positive. He continues to forge ahead while ignoring the relevance of negatives such as a surge in inflation in commodities, precious metals, and most importantly oil due to the systematic devaluation (destruction of the U S dollar) as well as the world wide chaos which has been ignited by inflation and rising food prices.

 The unintended consequence of these Fed actions will result in the only economic condition worse than inflation, which is “stagflation”, in which the inflation rate is high and the economic growth rate is low. What will make this condition considerably adverse is the inverse relationship between the U S dollar and oil prices. Oil prices have historically increased as the value of the dollar decreases. Oil prices can exceed their 2008  high of $148 .00 per barrel  especially considering the fact that with oil prices at a historic high in 2008, the value of the U S dollar  was considerably higher. The unintended consequence of a “weak dollar” which is supposed to spur exports and stimulate our economy is more inflation and greater upside pressure on commodities and oil than we saw in 2008.

 Merton believed that the ultimate flaw of mankind is hubris – our belief that we could fully control the world around us and that we put our immediate interest before our long term interests. Ben Bernanke and the central bank are guilty of “hubris”, as they continue to put their immediate interests before that of the nation’s long term interest. Their actions will force us to live with “unintended consequences” for decades to come.
 To quote French novelist and Nobel Prize winner, Albert Camus, “the evil in the world almost always comes of ignorance, and good intentions may do as much harm as malevolence if they lack understanding”. In our financial lives it is imperative to invest with the foreknowledge that we may have to endure many “unintended consequences” inflicted on us by a “well intentioned” government to achieve our financial success.
 Reason is our only defense. To quote Ayn Rand, “From the smallest necessity to the highest religious abstraction, from the wheel to the skyscraper, everything we have comes from one attribute of man … the function of his reasoning mind”.

Blissful Ignorance: Why the Financial Markets are Ignoring the Crisis in Egypt



There is little acknowledgement

of the trouble that lies ahead

when relying on a philosophy

of “blissful ignorance” in regards

 to Egypt and its impact on the economy.

The phrase “ignorance is bliss” is a passage from a Thomas Gray poem “Ode on a Distant Prospect of Eton College” (1742). The complete phrase, “Where ignorance is bliss, ‘tis folly to be wise” has often been interpreted as “what you don’t know can’t hurt you”. Unfortunately, using this proverb as the approach by which the United States deals with situations in the Mideast is a dangerous and destructive philosophy.

 

The most egregious U.S. foreign policy mistake of the last 50 years was Jimmy Carter’s decision to demand the Shah of Iran to step down, together with turning power over to the Ayatollah Khomeini. Carter’s ignorance as to who would fill the “power vacuum” was specifically what led to the grave situation we have in Iran today. President Mahmoud Ahmadinejad presides over one of the most perilous regimes the world has ever known — who exist for the purpose of destroying Israel and the United States.

In the recent Egyptian crisis, the mass protests endure, demanding an end to President Hosni Mubarak’s 30 year rule. It has become apparent that the result will be a “power vacuum” similar to the one created in Iran 30 years ago.

As much of the world applauds the possibility of a Western democracy, it’s important to acknowledge that few “revolutions” succeed without years and sometimes decades of extreme conflict — especially when such polar opposite parties are positioning for power. Organizations such as THE MUSLIM BROTHERHOOD have goals which harbor establishing SHARIA law throughout the world through world domination and Jihad. The Muslim Brotherhood has been banned from Egypt and will without question fight to fill “the power vacuum” to achieve its ultimate goal.
The Dow ended last week up 2.3% and the SP gaining 2.7% with the Nasdaq composite gaining 3.1% after stocks like JDSU (NYSE:JDSU), Aetna Inc. (NYSE:AET), Tyson foods (NYSE:TSN), all beat earnings estimates and conveyed a positive outlook for  the future.

The markets are paying very little attention to Egypt, instead focusing on what they view to be a continuation of the recent recovery. There is little acknowledgement of the trouble that lies ahead when relying on a philosophy of “blissful ignorance” in regards to Egypt and its impact on the economy.

1-The protests, although large in size, have been relatively peaceful giving investors the feeling that the transition to a democracy will be smooth and without consequence. Who can forget the image of the tank commander embracing one of the protestors? The United States has been sending charter flights to evacuate tourists and the press, leaving Egypt with very few objective journalists to talk about what’s actually happening. We are left to rely on a small number of correspondents for our information.

2-The Obama administration while expressing a need for political reform and having Mubarek step down, seemingly ignores the possibility of an “unfriendly regime” interceding. There is no mention of the threat of having Egypt become a “second Iran”. With a population of approximately 80 million each in Egypt and Iran, the combined opposition will be about 50% of the U.S. population, about 20 times the population of Israel, and can cause a shift to the dominant hostile presence in the Mideast.

3-The Obama administration is not acknowledging the talks held between the banned Muslim Brotherhood and Egypt’s Vice President Omar Suleiman. These talks involve massive concessions to the Muslim Brotherhood as an attempt to prevent a violent uprising. However, these efforts have a high probability of failure, greatly increasing the potential of violence in the region.

4-Investors believe the uprising is a result of the Egyptian people’s desire to become a democracy; however, it’s really food inflation which is the ultimate cause. Fitch Ratings determined food inflation in Egypt to be at 18% and Egyptians blame this on the Mubarek administration. Furthermore, the weak currency policy in both the U.S. and China has resulted in massive inflation, spreading throughout the world — including the US. Inflation will be the single biggest threat to the U.S. economy, the equity markets and the world economy.

Most of the economic and geopolitical  calamities we’ve faced as a nation have been the result of engaging in a policy of “blissful ignorance“, by ignoring “what is” for what we want things to be. The U.S. as a freedom loving democracy wants nothing more than to have our enemies retreat through concessions and eventually become our friends. What could be better than Egypt with its vast resources and Suez Canal to become “just like us”? This will not happen overnight in Egypt and we must have a realistic understanding of the long road ahead.

It is imperative that we abandon our “blissful ignorance” when it comes to the economy and understand the consequences of the inflation which we have played a big role in causing. We must recognize the potential of a massive security threat involving the potential of having “two Irans” as opposed to one.

To contend with difficult times like these, it is not “folly to be wise” and to quote Ronald Reagan, “We cannot play innocents abroad in a world that is not innocent”.

               

Thank You,

Jeffrey C. Sica

President

Sica Wealth Management, LLC

67 East Park Place, 1st Floor

Morristown, NJ. 07960

Tel  973-975-0730

Main  973-975-0750

Fax  973-889-1010

And The Loser Is ... Why Financials Will Be The Worst Performing Sector Of The Next Decade ... Again

It’s the much anticipated time of the year when the entertainment industry honors their own achievements by presenting the world with the nominations for the Academy Awards. These awards showcase the best of Hollywood, with critically acclaimed movies like “THE KINGS SPEECH” – leading the ballots with a staggering 12 nominations.

It is a night that everyone in the entertainment industry strives to be a part of. It is an honor to be given the opportunity to stand behind the podium and give an incoherent speech, which is far too long to be crammed into the allotted time, only to be cut-off by music or a commercial. It is those few brief moments when the world takes notice and entertainers can say, (as Sally Field did in her 1984 acceptance speech for her second Oscar, for the movie “PLACES IN THE HEART), “you like me, you really like me”.

In addition to the Oscars, there have also been nominations for the 31^st annual Razzies award. The Razzies are the polar opposite of the Oscars in so much as the audience chooses who are the absolute worst actors, actresses and movies of the year. There is an official show, however, most of the recipients are far too embarrassed to receive their awards or deliver speeches like “you didn’t like me, you really didn’t like me”.

In the coming year, we will see one sector perform so poorly that if they were movies, they would certainly receive the dreaded “Razzie” award. The first and worst performance of all, will come from the industry that investors love to hate — THE FINANCIAL SECTOR.

 Although rallying 162% from the market low of March, 2009, the financial sector is still off 51.9% from its October, 2007 market peak. This performance credits the Financial Sector with the worst performing sector of the decade award.

Industry wide revenues are off 17% since 2007 with recent figures flat or declining. Bank of America (NYSE:BAC) reported a 1.24 billion dollar loss its second consecutive, unprofitable period. The Securities and Exchange Commission charged Merrill Lynch, now owned by BAC, with securities fraud, for misusing customer order information. Merrill agreed to pay 10 million to settle the charges, further tarnishing the credibility and trust of customers.

Financials face new regulations which will greatly reduce profit margins in the years to come. The vast majority of what could be considered earnings has been mostly exaggerated, due to money being moved in and out of reserves. The impact of bad loans has yet to be disclosed by financial institutions and will only accelerate over time. This is further exacerbated with the exorbitant amounts of commercial real estate owned by banks and so they will begin to sell at a discount.

The Investment Razzie for the “worst“ supporting cast  was Citigroup (NYSE:C), who hid its massive leverage attached to risky loans by using complicated derivates and listing their balance sheet exposure as short term debt. In the months leading up to the crisis, Citigroup neither confessed nor admitted that their underlying exposure was “becoming a concern”. Instead, they gave investors the false impression that they had minimal exposure to risky loans and held sufficient insurance to protect investors from a drop in the value of the underlying securities in their general portfolio. Investors lost over 90%of their investment while Citigroup accepted a tax payer funded bailout of 25 billion dollars.

Some other memorably bad performances include: NYSE:WFC, NYSE:AIG, NYSE:JPM, NYSE:UBS, NYSE:GS.

The aftermath of the financial crisis of 2008 will be felt in the banking industry for years to come, making them the worst performing sector of the next decade as well as the last. They like so many “bad actors” will be type cast in the role of “villain” in their horrific and disingenuous performance.

In an industry which played such a historic role in the foundation of our country, it is very disheartening to see the depth to which these onetime “stars” have sunk, leaving many investors to walk down “the boulevard of broken dreams“. This “stroll” will be taken with much less of their investment assets than they would have had if only the banks would have acted with integrity.

In the final scene, financial institutions will realize that no attempt to “recast” themselves as the hero will prevail, considering investors will forever remember this performance as defining who they are and for the damage they’ve done. The Investment “Razzie” may actually be too high of an honor for this performance.

True Grit – Investing With A Vengeance

 This year Hollywood is ending the year with a vengeance amidst the remake of the 1969 classic, TRUE GRIT, which starred the original Hollywood bad ass, John Wayne. This exceptional remake is quite a divergence from the standard no plot, special effect extravaganzas, starring former Disney Channel celebrities we’ve grown accustomed to at this time of the year. The movie centers on 14 year old Matte Ross, (played by Hailee Steinfeld), who hires U.S. Marshal “Rooster” Cogburn, (played by Jeff Bridges), to find her father’s murderer and have him brought to justice. It is a movie that has virtually no special effects, manicured stars, illicit humor or any of the other so called successful ingredients of a Hollywood blockbuster — yet it had a very good opening weekend. This early success defies the logic of many movie critics who claim that revenge-themed westerns can no longer succeed in Hollywood as they once did. This may be proof that movie goers are getting a little tired of the same old “tricks” and want to be “entertained” and not just  “distracted”.

This year in the equity markets investors experienced what many would characterize as a “blockbuster” year with over 10% returns on the S&P 500 and upward of 17% in the NASDAQ composite. The hero, although not a former Disney Channel star, was Ben Bernanke who took center stage after being given the role of saving the world through his own special brand of “special effects” — quantitative easing. Here our headliner, Bernanke, creates “money out of nothing”, inflating everything since 2008 from stocks and bonds, to Gold up 89%, crude up 107%, copper up 230%, sugar up 154%, soybeans, wheat, corn and coffee – all up over 50%. All this in typical Hollywood fashion, trying to get us to believe that the “special effects” are in fact, reality and the economy is really improving. Also starring in this “blockbuster” market year is President Barack Obama who decided to “play the part” of supporting actor and sign an extension of the “Bush Tax Cuts”. This two year extension not to raise taxes, brought relief to those that the President referred to as “the villains” or what we prefer to refer to as the “job creators” or “investors“. This “performance” brought him concessions during the lame duck session which will increase our federal deficit by almost 1 trillion dollars, making his award winning performance “Oscar worthy”. Investors were successfully “distracted” by the special effects as they recaptured virtually “all” of their market losses since the market decline of 2008 — most unaware of what was happening “back stage” as our federal deficit grew to 14 trillion dollars.

 In the year ahead, it is highly unlikely that the same old “special effects” of 2010 will produce similar results in 2011. Ben Bernanke cannot use another round of QE without completely undermining the confidence of investors worldwide. The bond market bubble is beginning to burst and although a further round of QE could prolong that from happening, it will create a much greater bubble in the future. It is only by embracing certain facts and looking past the “distraction” to the reality, which will allow investors to achieve the “blockbuster” returns they are seeking.

1. Inflation is Here – Commodity prices especially oil will continue to surge, therefore stocks like EXXON (XOM), Schlumberger (SLB), National Oilwell (NOV) and ETFS like IEO (ishares Dow Jones Oil and Gas exp) and IEZ (ishares Dow Jones Serv) or companies like Reynolds (RAI), Dupont (DD), Archer Daniels Midland (ADM), or Powershares DB Agriculture (DBA) will benefit from higher agricultural prices.
2. Income is dead – Investing for income is a waste of time, considering bond prices will continue to decline. Stay invested in short term bonds and buy quality dividend paying stocks like Kimberly Clark (KMB), Kraft (KFT) and Duke Energy (DUK).
3. Municipal and local municipal bonds will see historic defaults due to high levels of leverage. As a result, it would be prudent to greatly reduce municipal bond holdings.
4. Precious Metals will continue to advance.
5. The direction of the market will be determined by whether or not we see an improvement in unemployment.

Mattie Ross, “True Grit’s” 14 years old main character, chose the “tough as nails” U.S. Marshal “Rooster” Cogburn, to find her father’s killer because in her words, “he was true Grit”. He wasn’t your typical hero but he knew the terrain and had no fear when it came to accomplishing what he set out to do. Mattie Ross was described as having “steel in her spine” and a face that “couldn’t hide her broken heart “. In the challenging year ahead, we too must have “true grit” in enduring the economic challenges which lie ahead of us. We too must have “steel in our spine” even when some of our investments leave us broken-hearted. This will be a volatile year and we must look past the “special effects” and “distractions” which inflated this market, to a more “true” foundation. In the end, like Mattie, we will accomplish exactly what we set out to do.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

QUANTUM PHYSICS AND THE ECONOMY – How the Bond Market ‘BUBBLE’ Affects the Overall Global Economy

This year the Nobel Prize in Physics was awarded to Andre Geim and Konstantin Novoselov from the University of Manchester in the UK for the discovery of a completely new material named Graphene. This new substance when extracted from graphite such as “found in a common pencil“, and is stabilized and mixed with certain plastics can be transformed into Graphene conductors believed to be the fastest conductors of electricity known to man — substantially faster than today’s silicon transistors. This amazing discovery could lead to faster, more efficient computers as well as other sorts of high frequency communication devices. This advance in the field of Quantum Physics brings to light an often ignored aspect of investment strategy —  the relevance of the interdependence of asset classes in achieving investment results. To continue with our Graphene example, it is the interdependence between the Graphene and the plastics that transform them into conductors of electricity — not simply one isolated element.

The most relevant and recent example of asset class interdependence is what investors have been witnessing in the bond market. In the past few weeks, the interest rate on five year treasuries has doubled to 1.9%. The rate on the 10 year jumped to 3.4% from 2.4%. The rate on the 30 year treasury is currently at 4.4%, a full percentage point higher than it was only a few months ago. These higher yields equate to lower bond prices which, in effect, wipe out years of interest, considering there is an inverse relationship between price and yield. Investors looked to bonds as an answer to their fears regarding an uncertain recovery and experienced some of the “best ever” returns — making mutual funds like the Pimco Total Return Fund grow assets to over 250 billion. If the majority of the appreciation in the bond market was the result of investor demand, we could rest easy knowing that the free market would prevail and even a correction could be bearable and, maybe even considered a “buying opportunity”. Unfortunately, this is not the case. Investor demand is not the only reason the bond market has appreciated to this level. The bond market has expanded due to the Federal Reserve’s misguided experiment of “printing money” or “quantitative easing”, which has artificially inflated bond prices. Investors realized that with yield so incredibly low, bonds offered little reward for lots of risk and instead of exiting in an orderly fashion through the main exit, they ran the risk of a continuing stampede through any exit, leaving many investors wondering — what happened?

 One of the significant differences of today’s average investor as opposed to investors of the past few decades is that substantially more of their money is invested in bonds and bond funds than ever before — an estimated 3 trillion dollars. Investors gravitated toward longer maturity bonds in an effort to secure higher coupons since older investors often rely on interest payments to sustain their income. These longer term bonds are most susceptible to loss of principle in a rising interest rate environment. For example, if long term bond yields move to 7%, the loss will be 25%. A 25% decline to an older investor with fewer years to try to recapture the loss is often catastrophic, greatly affecting spending and confidence and in turn affecting the overall economy. Investors who thought they found solace in the higher yielding corporate bonds will also suffer since once treasury yields rise and investors can get similar returns from “higher credit quality“ government bonds, corporate bonds will also come under considerable pressure. This too will have an impact on spending and consumer confidence.

Investors who are under the assumption that the stock market can continue its upward surge if the bond market continues its decline, will  be very disappointed when they find that much of the appreciation resulted from money flowing into dividend paying stocks from investors who were seeking income but couldn’t find what they were looking for in the bond market. Corporate earnings will be exceedingly affected in so much as corporations will not be able to issue long term bonds at low rates to fund their growth — greatly affecting their profits and essentially their stock price. Investors will always gravitate toward assets which give them the greatest return for the least risk. If bond prices continue to fall, the enthusiasm to take on more risk in equity will wane as investors seek similar returns in the higher credit quality treasury bonds. The equity market has been the beneficiary of the interdependence it has developed with the artificially overbought bond market and it will be this correlation which will cause the equity market to decline as the bond market declines. Ben Bernanke has hinted that he’s not opposed to a QE3 which may elevate bond prices in the near term but create an even greater “bubble” in the long term, spurring a considerable inflation threat.

In Quantum Physics as in investment strategy it is often the combination of the simplest elements which create the most spectacular results or the greatest catastrophes. Whether it’s the Graphite in a pencil or stocks and bonds as a part of an investment strategy, it is how those elements interact that make them just plain graphite or the fastest conductor of electricity known to man — or just plain stocks and bonds or the core component of a strategy which ultimately protects and grows what you’ve taken your whole life to accumulate. The method used to take a carbon atom in graphite and make it useful is a process referred to as “stabilization”, once considered to be virtually impossible. In the financial markets of today, many “experts” consider another type of market stabilization to be impossible, however, through diligence and discipline we will ultimately achieve the investment success we strive for and understanding the laws of Quantum Physics will help us get there.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

High Net Worth: SPIRIT OF FREEDOM-What the Conflict on the Korean Peninsula Means to the World Economy

High Net Worth: SPIRIT OF FREEDOM-What the Conflict on the Korean Peninsula Means to the World Economy

SPIRIT OF FREEDOM-What the Conflict on the Korean Peninsula Means to the World Economy

She’s a beautiful vessel, about 1,092 feet long , 257 ft wide and 244 ft high. She has an enormous flight deck, 4.5 acres long which could accommodate up to 80 aircraft — each armed with the most sophisticated weaponry known to man. She has a crew of 6,250 brave men and women. Her name is the USS GEORGE WASHINGTON, and she has recently been deployed to the Yellow Sea, west of the Korean Peninsula, to begin joint military exercises with South Korea. In a statement from the US Navy’s seventh fleet, the military exercises are described as a measure to show the United States’ “commitment to regional stability through deterrence.”  In other words, what we are saying to the dictator Kim Jong Il and his “20 something” heir, apparently Kim Jung-un, is that we mean business when it comes to protecting our allies. The mere presence of this symbol of US power should inspire them to back down. It’s impossible to predict what the NORTH will do, since they continually act in a defiant, irresponsible manner — most notably in a recent revelation that there is a uranium enrichment facility in North Korea which could further advance their existing nuclear capabilities.

The most important aspect of this confrontation is how North Korea’s closest ally, China, deals with their recent aggression and insatiable need to advance their nuclear capabilities. China has a long history of using North Korea as a buffer against the US. Since the end of the Korean War, they have been leery of our strong alliance and our military presence in South Korea. They have never welcomed having our warships anywhere near their coastline. Furthermore, they have yet to firmly condemn North Korea on the attack of a South Korean warship which killed 46 sailors last March, the revelations of their nuclear capabilities or the most recent events. Alternatively, China, in a statement from its foreign ministry regarding our military exercises, has chosen to warn the US against “any military acts in our exclusive economic zone without permission.” In other words, China is threatening the US not to come too close to their coastline or face consequences. This statement by China will only serve to encourage the radical Korean dictator and his offspring to further threaten South Korea and defy the US. It should concern the Obama Administration that the strongest stand taken by the Chinese has been against the US protection of our allies, and not against the aggression of a radical dictator.

 The US market fell this week amid concerns that the Korean peninsula conflict will escalate. The bulls have chosen to focus on this conflict as yet another example of “saber rattling” from North Korea, but its consequence could be far greater than ever before, considering a few key factors. FIRST, China has the greatest influence over North Korea and how they handle them will substantially affect the world economy. SECOND, China is the largest foreign holder of US Government debt in the history of our nation, with holdings of nearly 900 billion dollars. This position gives them significant leverage over the US and substantially undermines our ability to negotiate with them when they side against us, as they seem to be doing now. THIRD, China has systematically devalued the juan in response to QE2 creating the dawn of inflation as we are beginning to see now and will soon see in the US. The recent interest rate increase in China has yet to show signs of curbing inflation. If the US and China are unable to come to terms with the conflict in the Korean Peninsula, it is unlikely they will come to terms with stabilizing their currencies — continuing on a path of systematically devaluing  currencies and creating a future threat of inflation while undermining a worldwide economic recovery. Finally, an insane dictator with nuclear weapons that is not kept at bay, by its closest ally and neighbor, is always a threat to the economy and well being of nations throughout the world. China has a responsibility to help stabilize the region and until they do, uncertainty and fear will remain throughout the worldwide financial markets, keeping us in a very defensive position.

The USS GEORGE WASHINGTON has an insignia designed by the ship’s crew, which includes a classic profile of Americas first president, a band of thirteen stars representing the original thirteen colonies and the crossed flags of freedom — all encircled by an unbroken rope representing the solidarity of the crew. The motto of the ship originates from the namesake, George Washington himself, taken from a letter he wrote to a fellow patriot. Washington used the phrase, “THE SPIRIT OF FREEDOM”, to describe the mood of the people during the revolutionary war. Perhaps we should reflect on the words of George Washington when considering the future of our nation, for it is the “Spirit of Freedom” which will motivate us to stand by our allies in times of trouble, when their freedom is at risk. It is the “SPIRIT OF FREEDOM” that will guide us through the challenges which are before us —it can never be taken away.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

MEGAMIND

Who Are The HEROES And The SUPER-VILLAINS Of The TRADE And CURRENCY War?

In the DreamWorks animated hit film, “Megamind”, the self proclaimed “most brilliant super-villain the world has ever known”, was unfortunately for him, also the least successful. He regularly tried to conquer Metro City in every conceivable way, only to be defeated by his nemesis superhero “Metro Man”. In this week’s coverage of the G20 meeting in Seoul South Korea,  the “group of 20 nations” converged for their biannual summit, designed to strengthen macro policy co-ordination, consolidate global economic recovery and promote strong, sustainable balanced growth — or at least that’s what they say they are meeting for. In reality, they are meeting to determine who the super-villain is and who the hero is — or in the language of DreamWorks’ Megamind, who Megamind is and who Metro Man is. The United States alleges China is the super villain due to China’s record 28 billion trade surplus with the US, as well as the unfair cap on Yuan appreciation — both detrimental to US business interests. China asserts the US is the super villain since they consider the most recent 600 billion in quantitative easing a scheme to give US exporters an unfair advantage — one that endangers the global economy. It’s evident that neither side will concede to take any responsibility. This situation is best summarized by the Director General at China’s Ministry of Commerce, Yu Jianhua, who said, “Don’t make other people take the medicine for your disease. Quantitative easing will have a very big impact on developing countries including China.”

Investors will be faced with dramatic distortions looming in the post-crisis global economy as a result of this failure to come to terms with the currency crisis and trade imbalance. Countries have already begun to seal off their markets against foreign products in an effort to protect domestic producers. This will have a dramatic impact on countries that have become overly dependent on a weak currency to stimulate economic growth. In the context of China and the United States, who seem to be in a race to devalue their currencies, this could be disastrous. Key emerging economies, most notably Brazil and Indonesia, are imposing restrictions on the movement of capital, which could greatly disrupt the global money cycle. President Obama is beginning to embark on an offensive to pillory countries with chronic trade surpluses like China, Japan and Germany. This initiative will ultimately fail since many countries such as Germany believe that the US policy of QE is the cause of most of the recent global economic turmoil.

The result of this historic war which is beginning to heat up will be rampant, unwanted inflation as recently illustrated in China. Consumer prices are climbing to startling levels with a 4.4% increase overall and a 10.1% increase in the food sector in October. The Chinese government is beginning to realize that they kept interest rates too low for too long and are trying to catch up by raising interest rates in October. The United States has not seen the level of inflation consistent with China, however, if the fed is too slow to lift interest rates and discontinue QE, we may find ourselves in a situation comparable with China in which we are too late and inflation will greatly hinder our ability to recover.

As a result, we are continuing to invest in commodities, agriculture, precious metals, base metals, oil and gas exploration, oil and gas equipment and services as well as natural gas. We are very concerned with the equity market, recognizing that the recent gains are considerably unwarranted and enhanced due to the euphoria of QE2 and the recent stalemate in the election. Consequently, we are staying with our short positions and inverses in anticipation of a pullback in the US equity market. We see continued weakness in the euro and are investing accordingly. The recent round of quantitative easing will fail to keep bond prices high with yields low so we will continue to short the long term Treasury bond, seeing virtually no opportunity in bonds.

In “MEGAMIND” the hero is ultimately defeated by the super-villain, only to reveal  a worse, more dangerous  villain than the original super-villain — forcing the super-villain to ultimately become the hero and defeat the new super-villain — a pretty complicated plot twist for an animated film. The story line in the currency and trade war is complicated as well, but, one fact has persisted throughout the past 234 years in this country and that is when we are faced with a challenge, even when policy mistakes are made, America ALWAYS ultimately emerges as the hero — even when others may think we are the villains.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

Great Expectations

In the Dickens novel “Great Expectations”, the main character Pip, a young working class orphan, inherits a fortune from an unknown benefactor and becomes instantly rich. He abandons all he knows, embraces his “great expectations” and pursues the life he has always aspired to. However, this sudden unforeseen success is muted due to subconscious feelings that he is unworthy of his good fortune and sadness and heartache ensues. In the recent market rally with the S&P 500 raising as much as 16% from its low in July, one would think investors would become more optimistic about the economy. Conversely, a recent poll found that just 37% of the public believes that the economy will improve in the next year — this down five points from a year ago. Those following technical analysis also have reason for “great expectations” as the SP 500 50-day moving average crosses above the 200 day moving mark, indicating the short term positive direction of the market is likely to continue. Additionally, the market historians have reason to be optimistic whereas for the past sixty years, the markets have typically performed tremendously well during midterm elections — averaging double digit returns consistently with only a few down years. In my last post, I discussed “embracing the stalemate” referencing the potential stalemate in the government which historically has proven to be the best possible environment for stocks. Even those that rely on corporate fundamentals have a reason for “great expectations” considering 85% of the 132 companies in the S&P 500 that reported earnings since October 7 have topped analyst per-share earnings estimates.

So why do so many of us share the dampened spirits of the young man in the novel “Great Expectations”? Perhaps because we feel that somehow the recent gains are not truly deserved and the potential for losing them looms large. The focus of the meeting of finance ministers and central bankers in the G 20 this weekend was to address the growing problem of countries relying on weaker exchange rates to spur economic growth. The ironyof the meeting centered around Timothy Geitner “expecting” China to allow the Yuan to strengthen in the interest of domestic growth and global economic stability. Geitner failed to mentionthe fact that the dollar is at a 15 year low due to the excess and potential future use of quantitative easing but did say for the first time, that it’s in the best interest of the United States that we have a strong dollar. If we are to have a strong dollar the quantitative easing estimated to begin in early November and projected to amount to over 1.4 trillion dollars (with recent predictions by Goldman Sachs analysts of 2 trillion) needs to be curtailed significantly. The overall rationale responsible for much of the advance of the market has been QE and, in the likely event that it is reduced or eliminated, the effect on the market will be negative — if in fact it was the main reason for the market advance. The Chinese will make small symbolic gestures to give the illusion that they are not manipulating their currency resulting in devaluation of the weaker currencies and worldwide inflation. Anyone disbelieving that cheaper currency is not a concern for weaker economies, should consider the tax Brazil imposed on foreign capital as a way to protect their currency and reduce the potential impact of inflation.

This rally will continue to run as long as the government pumps money into the economy; however, when it stopswe will need to prepare for a pull back. In the verbiage of Timothy Geitner, although not yet repeated by Ben Bernanke, that we are given the hint that QE may end sooner than we think, the central bank and Geitner face an insurmountable challenge. It’s impossible to strengthen the dollar and head off inflation without ending QE. If they end QE, they risk the stock market falling and the economy slowing further. The decision they need to make — whether to artificially pump up the economy or let the free market prevail and find other ways to stimulate growth — such as tax cuts. If they continue to artificially inflate the economy, they will cause worldwide rampant inflation which could find its way into our economy sooner than we think. We are continuing to trade this market short term, utilizing tight stops on our long positions — buying commodities, precious metals, base metals, mining stocks and using inverse ETFs to short the US treasury in anticipation of bond prices falling. We also feel that the Euro is overvalued and we expect a pullback.

Many people consider the novel “Great Expectations” a tragedy insomuch as the young man loses everything he has — counting too much on what he does not already have and valuing too little of that which he does have. However, it was in the lessons he learned and the love he attained which brought him true happiness in the end. In our “great expectations” that we have for the future of our nation and our personal economic life, we should always remember — we don’t need to lose everything to achieve the success we desire, if we  pursue our goals with unrelenting discipline and diligence. In a quote by Dickens himself he proclaims that, “there is nothing so strong or safe in an emergency than the simple truth”.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

Glee: Embracing the Stalemate

Glee is back. I’m not referring to the FOX hit series that premiered a few weeks ago which highlights a diverse group of high school students who solve all of life’s problems with a song — ending last season on a high note with their rendition of Journey’s “Don’t Stop Believing”. I am referring to the recent performance of the DOW which topped 11,000 for the first time since the May 6th crash despite the report from the labor department that the nation lost95,000 jobs last month — signaling that the recovery is faltering. Ben Bernanke led the central bank in their version of “Don’t Stop Believing”, as he hinted that they would continue to buy up to 1.2 trillion of treasuries, believing that injecting cash into the economy would finally spur growth. It has been my contention that this quantitative easing will be a detriment to the long term health of the US economy. It has done nothing but artificially inflate bond prices and destroy the value of the dollar which is now trading at 81.73 yen — a fifteen year low.

So what are investors so Gleeful about? In most cases, a stalemate is not something to break into song over. Anyone who has ever been involved in a negotiation which ends in a stalemate is usually disappointed, because virtually nothing has been accomplished. The upcoming elections will most likely shift the House over to the Republicans, with the Senate very much up for grabs — the end result will probably be a stalemate. The recent rally is a celebration of “nothing” which is exactly what the government will be doing in the next couple of years until the next Presidential election — “nothing”. However, in the case of the current tax policy, doing nothing is impossible since the current tax policy will expire in January — possibly ending the initiative that’s been in effect since 1996. Possibly ending the very same policy that lowers taxes for small business’ or job creators and investors — the people who President Obama refers to as the “wealthy”. The expiration of the Bush tax cuts will have many negative effects, but the most relevant is the profound effect the Obama tax plan will have on small business’ willingness and ability to hire. It’s simple math — the more a small business owner pays in tax, the less money he has to hire workers. If the sky high unemployment rate continues or increases, no amount of quantitative easing, government bailouts or empty promises will prevent the debacle ahead. Every single government initiative that this administration has put forth has failed miserably; hence, investors eagerly anticipate the government continuing to do absolutely nothing after the Bush tax cuts are extended.

In the midst of our “gleeful nothingness” it is imperative to hypothesize the effects rising interest rates will have on our portfolios. I know that some believe that a brilliant congress will prevail in restoring the value of the dollar, while keeping interest rates low, without Central bank intervention. The optimist in me wishes that were true, but in order for the economy to improve, it will have to endure the hardships associated with rising interest rates. My short term strategy reflects four main factors:

1. Interest rates will rise (bond prices decline)
2. Commodity prices will rise exponentially (including OIL)
3. The stock market will continue to rally in anticipation of the stalemate
4. Precious metals will rally until interest rates rise and the dollar stabilizes.

However, in all likelihood, the stock market will become vulnerable to a decline when interest rates increase and unemployment doesn’t improve — which is why I remain negative on the equity market in the intermediate term once this short term rally runs its course. Our strategy is to trade the rally short term — continue to buy commodities, precious metals, convertible bonds and inverse treasuries, ETFS as well as TIPS . We are hedging our equity with Inverse ETFS and holding short term, while maintaining tight stops on our long equity positions, with less tight stops on our short positions, and inverse ETFS — recognizing that the market is vulnerable at these levels.

In the show “GLEE” turmoil ensues throughout the show, but what people remember and talk about is the final song. In the real life economic turmoil of today, we will surely persevere if we hold onto the fundamentals that have made this country GREAT. Conditions are far too complicated to ever think that all economic problems and problems in general could be solved with a song, but it is a song — possibly the best song ever written that will make us forget all the turmoil that created this crisis. The song was written by Katherine Lee bates, and it’s called “AMERICA THE BEAUTIFUL”.

Thank You,
Jeffrey C. SicaPresidentSica Wealth Management, LLC